The Standard & Poor's logo is displayed at the company's headquarters in New York. New Jersey has filed suit against the company over rosy credit ratings it assigned to complex securities before the financial crisis.
(Scott Eells/Bloomberg)

New Jersey has accused the rating agency Standard & Poor’s, and its parent company McGraw Hill Financial, of violating the state’s Consumer Fraud Act over the rosy ratings it assigned certain complex securities that ended up going bust during the financial crisis.

The lawsuit, filed today in Superior Court in Essex County, charges S&P with misleading consumers about the independence and objectivity of its ratings of structured finance securities, the state’s Office of Attorney General said. It follow similar actions by both other states, including Pennsylvania and Indiana, and the U.S. Department of Justice.

According to New Jersey's complaint, S&P assigned ratings that were driven not by unbiased assessments, but by its own revenue goals and a desire to not alienate investment banking clients, who might otherwise turn to one of its competitor agencies.

“The independence and objectivity of Standard and Poor’s is of critical importance to New Jersey consumers, who placed their trust in the company’s supposedly objective analysis,” acting Attorney General John Hoffman said in a statement. “Our lawsuit alleges that this trust was misplaced.”

Ultimately, the state says, competitive pressures facing S&P undermined both its ratings methodology and its ability to monitor the performance of the securities it had already rated.

Prior to the financial crisis, banks regularly created structured securities, such as vast pools of residential mortgages and other debt arranged in different layers, or tranches, of risk. Before selling these on to investors including pension funds and insurance companies, the banks paid rating agencies to grade the likelihood that the security would be repaid. However, many structured products that were rated of top quality ended up defaulting, causing huge losses to investors that had expected lower risks.

The lawsuit also notes that S&P, which charged significantly more to rate structured finance securities than corporate bonds, saw its revenue hit $12.7 billion in 2006, a 15 percent increase that the state says was attributed largely to these higher fees.

An S&P spokesman said the company would defend itself against the litigation.

“New Jersey and other states have filed meritless civil lawsuits against S&P challenging our ratings on structured finance securities. The claims are simply not true and we will vigorously defend S&P against them,” the spokesman, Edward Sweeney, said in a statement.